A sharp decline of 1.1 trillion. euro is expected to be raised from liquidity European banks by 2024, after more than a decade of cheap money from European Central Bank, with the biggest “test” expected on June 28 this year, when they will have to “pay” the central bank 477 billion euros. This amount is about cheap long term loansthe well-known TLTROs that the ECB has provided to the sector since the outbreak of the pandemic in 2020 so that they can continue to support the economy in the midst of general lockdowns.

From the fourth quarter of 2022, eurozone banks began to prepay these loans, which peaked at €2.2 trillion. euro in mid-2021 (or up to 20% of the total liquidity of the Eurosystem), following a corresponding recommendation from the ECB in the context of a strategic reduction in its balance sheet. So far, about 900 billion euros have been repaid in small payments without a significant impact on the market.

The TLTRO III Targeted Long-Term Refinancing Program enabled banks, in addition to lending to businesses and households, to increase their liquidity buffers and strengthen their size as they borrowed from the ECB at a negative interest rate. rate that reached up to and -1%, much lower than the ECB’s deposit interest rate. The ECB even calculated that these loans cut lending rates by up to 60 basis points, the equivalent of a significant rate cut. Some banks also increased their profitability by taking these loans and re-depositing them back with the ECB to earn higher interest rates.

The TLTRO redemption is a major milestone for the industry following the recent banking turmoil in the US and Europe.

However, from November 2022, the central bank changed the terms of TLTRO III, encouraging banks to repay these loans ahead of schedule. With the ECB raising interest rates faster than expected due to soaring inflation, European banks benefited both from these ultra-cheap three-year loans and from higher interest rates, which was effectively a “subsidy” from the ECB to the banks. Thus, the ECB has deemed it necessary to adjust this program to ensure its compatibility with the broader monetary policy normalization process and to increase the pass-through of policy rate hikes to bank lending conditions.

As such, the interest rate on these financial transactions is now pegged “to the ECB’s average applicable key interest rate for a given period,” according to the related announcement.

European banks have certainly improved their liquidity and funding positions both over the last decade and since the global financial crisis, they are much better capitalized and the non-performing loan ratio hit a record low of 1.8% at the end of 2022.

The TLTRO payout, however, is a major milestone for the industry after the recent banking turmoil in the US and Europe rocked markets in March and cast doubt on investor confidence in the system, with market attention shifting to potential liquidity and funding issues that could encounter some banks. . A large “dose” of 477 billion euros in June, as well as the final termination of this support, which exceeded 2 trillion. euro, increase pressure on banks, especially the most vulnerable, worsen already tightened lending and lending conditions, and raise the cost of financing, which could hurt economic growth.

Removing TLTRO as a source of cheap funding for banks will exacerbate the current slowdown in credit growth (year-on-year) by about 1.4% each month on average, according to Allianz Research calculations. On the markets side, there is expected to be a significant impact on corporate credit risk pricing, with corporate bond spreads widening by as much as 50 basis points.

International Monetary Fund warned of these implications in a recent financial stability report. “European banks may need additional liquidity support when the mandatory payments on long-term refinancing operations (TLTRO) end. Looking at the share of TLTROs maturing until June 2023 versus excess liquidity available for redemption reveals potential fragmentation risks – banks in some Southern European countries that continue to rely heavily on short-term TLTROs tend to be the same ones that have there is not enough excess. liquidity for repayment,” the IMF said.

The position of the 4 Greek systemic banks is strong

Analysts and investors will be keeping a close eye on European banks’ liquidity coverage ratio (LCR) over the coming period, which essentially measures how much of a bank’s easily traded assets, such as bonds, compared to its deposits, i.e. short-term liabilities. According to the regulatory framework, the minimum limit of the index is 100%.

Deutsche Bank estimates that European bank balances in central banks are 3.4 trillion. euro, that is, the excess is 2 trillion. euro compared to 100%, which is the minimum required coverage ratio. However, banks want to have a “safe” surplus, with the ratio reaching 130% rather than 100%, which means that there is actually 880 billion euros of excess liquidity in the system.

Deutsche Bank estimates that the average LCR after full redemption of TLTRO III will decrease from 153% at the end of 2022 to around 135% in European banks. This is still well above the regulatory minimum of 100%, but perhaps closer to the 130% that banks want.

The TLTRO program is the financing of objects with guarantees (pledges). Banks deposit collateral with the ECB (with a certain haircut) in exchange for liquidity. Some of these collaterals are High Quality Liquid Assets (HQLA), but not all. When the TLTROs are redeemed, liquidity will decrease, but the banks will get back the collateral they “deposited” with the ECB. Thus, depending on the type of collateral, this can significantly affect the bank’s liquidity when it comes time to repay.

In this regard, Deutsche Bank singles out Greece and Greek banks. As he points out, a very large percentage of Greek banks’ collateral is high-quality liquid assets. These are Greek government bonds with a high haircut. As such, TLTROs are much more “guaranteed” than any other country. Therefore, although Greek banks have a high share of cheap TLTRO loans, the real impact of their full repayment is much less negative due to the quality of the collaterals. Thus, any decrease in the coverage ratio is easily offset by other balance movements.

It is worth noting that the four Greek systemic banks in total attracted about 50.8 billion euros from the ECB’s TLTRO, and at the end of February these funds decreased to 31.3 billion euros, i.e. they actually returned 19.5 billion euros to the ECB. The rating agency DBRS indicates that the full repayment of these funds is quite feasible for Greek banks, although their partial replacement will lead to higher refinancing costs.

According to Deutsche Bank, the coverage ratio of Greek banks in case of TLTRO redemption will be much higher than the European average (135%), and will reach 155% from 194% at the end of 2022.

Exhibition

“Banks in some southern European countries that continue to rely heavily on short-term TLTROs generally do not have sufficient excess liquidity to repay them,” the IMF Financial Stability Report notes.

477 billion

Euro European banks must “pay” the ECB on June 28
cheap TLTRO loans they got.

Effect

Removing TLTRO as a source of cheap funding for banks will exacerbate the current decline in credit growth by about 1.4% each month on an annualized basis, leading to widening corporate bond spreads, according to Allianz Research.

19.5 billion

Euro Greek banks returned to the ECB, as they received a total of about 50.8 billion euros from TLTRO III.

Managed

Full repayment of TLTROs is quite feasible for Greek banks, given the comfortable level of liquidity in the industry with an average liquidity coverage ratio close to 200% at the end of 2022, although their partial replacement will lead to higher refinancing costs, notes rating agency DBRS. .